Don’t fear the yield curve

There are always a lot of things to worry about in our economy. The yield curve isn’t one of them.

What is it about us humans that attracts us to negative news and, especially, negative forecasts? It might be worries about our fragile existence, but whether it is this or some less cosmic cause we do love our doomsayers.

It isn’t a product of our times. In literature, for example, we have Shakespeare, who understood human nature as well as anyone, having Julius Caesar warned by a soothsayer to “beware the ides of March.” Earlier, of course, the Greeks had their Oracle at Delphi, where Pythia foretold the future. Delphic forecasts tended to be worded such that they would come true no matter what occurred — a tendency memorialized in our language as “oracular.”

While there are some similarities, oracular is too harsh a term for the “inverted yield curve” as an economic indicator. Rightly or wrongly, it did furnish the basis for the recent flurry of doomsaying and investor worries about a recession. But as a predictor, it is less than perfect.

A yield curve is a line graph that shows and compares market interest rates for short-term and long-term debt securities having the same credit risk but different maturities. While there are as many yield curves as there are debt securities, the yield curve most commonly referred to is for U.S. Treasury bonds.

A normal yield curve slopes upward; that is, the interest rate goes up as the maturity date gets farther and farther away from the present and the perceived risk rises. It’s called a yield curve because the interest rate shown on it is the effective interest rate, which takes into account the current market price paid for the bond — which may in fact be higher or lower than the original par value.

It’s called a curve because economists call almost all line graphs curves, even those that resemble or are straight lines. Real yield curves typically are curved, but occasionally are nearly straight. The theoretical, “normal” yield curve is straight and rises as the time to maturity increases.

Inverted yield curves slope downward and have preceded a lot of recessions but if it were a dependable indicator we would have shut down our economic research and forecasting efforts a long time ago. To start with, the negative yield curve as an indicator leaves out a couple of key pieces of information: time and intensity.

Throughout American history our economy has never been in equilibrium. It was and is always expanding or contracting. If the economy is expanding, then, it doesn’t take a genius or a fortune teller to say that a recession is coming. You will probably be right…eventually. And that is equally true if the economy is in recession and you predict that a recovery is coming. Right again, eventually.

An economy predictor that leaves out the “when” entirely or provides a wide block of time is of limited value, similar to predictions of the “big one” hitting California maybe tomorrow or maybe in 10,000 years.

The second thing left out is a measure of intensity. Just how negative is the yield curve? It would make sense that a steeply sloped negative yield curve would be a stronger indicator than one that was barely negative. But all negative yield curves are lumped together, usually, and many investment analysts reach for the alarm bell whenever the yield curve starts to flatten out.

The yield curve is all about investor expectations — for the economy and, more particularly, for the Fed’s monetary policy position. If investors believe that the Fed is going to raise interest rates to cool down the inflationary forces in the economy they will respond by shifting demand, which tends to flatten out the yield curve.

The yield curve itself does not present a threat to the U.S. economy, but it does reflect a change in bond investor expectations about Federal Reserve actions and about the durability of our current economic expansion, now just 12 months away from being the longest in history.

Much of our economy relies on debt, and the so-called “entitlement” sector of government spending is dependent on investors parting with cash to purchase trillions of dollars of the federal government’s debt. That means that the investor expectations reflected in the yield curve have some weight. However, it is good to remember that the negative yield curve may simply be the result of a delayed reaction of long-term interest rates to the economy’s expansion. If long-term rates were to rise, the inversion of the yield curve would disappear.

There are always a lot of things to worry about in our economy — short range and long range. The yield curve, however. isn’t one of them. It just shows that some other people are worried, too. It doesn’t mean that they are right.

James McCusker is a Bothell economist, educator and consultant.

Talk to us

More in Herald Business Journal

Commercial Aircraft Interiors General Manager James Barnett stands in a warehouse aisle of 777 overhead bins at the company's new building on Monday, May 20, 2019 in Arlington, Wash. (Andy Bronson / The Herald)
12 Snohomish County aero firms get $19M for job protection

The Aviation Manufacturing Jobs Protection grants could save 2,280 Washington jobs for up to six months.

FILE - The logo for Boeing appears on a screen above a trading post on the floor of the New York Stock Exchange, Tuesday, July 13, 2021. Despite the pandemic's damage to air travel, Boeing says it's optimistic about long-term demand for airplanes. Boeing said Tuesday, Sept. 14, 2021 that it expects the aerospace market to be worth $9 trillion over the next decade. That includes planes for airlines and military uses and other aerospace products and services. (AP Photo/Richard Drew, file)
Pandemic hasn’t dimmed Boeing’s rosy prediction for planes

The company is bullishly predicting a $9 trillion market over the next decade.

Washington August jobless rate was 5.1%; 16,800 jobs added

August’s rate was the same as July’s rate, and increased even as COVID-19 cases surge.

Boeing moving 150 jobs from Washington and California to Texas

The affected jobs are in the company’s global parts distribution unit.

School-age lead Emilee Swenson pulls kids around in a wagon at Tomorrow’s Hope child care center on Tuesday, Sept. 7, 2021 in Everett, Washington. A shortage of child care workers prompted HopeWorks, a nonprofit, to expand its job training programs. Typically, the programs help people with little or no work experience find a job. The new job training program is for people interested in becoming child care workers. (Andy Bronson / The Herald)
HopeWorks to offer career training for child care workers

The Everett nonprofit hopes to train workers as child care centers struggle to hire staff.

Genna Martin / The Herald
David Barney, owner of Barney's Pastrami on Evergreen, has changed the last names of the dozens of celebrities who's photos hang on the wall of his restaurant to Barney.  The newly named celebrities include Humphrey Barney, Uma Barney, Marilyn Barney, Olivia Newton-Barney and Stevie Ray Barney.  
Photo taken 11252014
Where’s Barney? His pastrami shop has served its last hoagie

Even the Evergreen Way deli’s landlord is looking for him. David Barney has vanished.

Tasty and healthy asian food - spicy ramen with wheat noodle, meat, eggs and onion in white pot with chopsticks. Vector illustration of traditional korean cuisine for menu, recipe books or printing
You voted: The best Vietnamese food in Snohomish County

Even during a pandemic, folks still have their favorites.

‘Fulfillment center’ proposed along Bothell Everett Highway

Amazon denies that it’s involved in the project. But permitting documents include the company name.

A drawing of the giant Funko Pop! balloon depicting Baby Yoda, which will wind through the streets of New York during this year’s Macy’s Thanksgiving Day Parade. (Funko) 20210912
It’s OK to Pop! this balloon: Funko to join the Macy’s parade

Funko’s incarnation of Baby Yoda will float by in this year’s Thanksgiving Day event.

The Home Depot in Lynnwood on Sept. 3, 2021. (Andrea Brown / The Herald)
Lawsuit: Home Depot doesn’t give workers enough breaks

The suit could cover at least 10,000 employees across the retailer’s 45 locations in Washington.

Its business as usual in spite of construction starting on the Harvey Airfield runway on Thursday, Sept. 9, 2021 in Snohomish, Washington.  Planes use the grass/dirt runway as the asphalt runway gets a new facelift. (Andy Bronson / The Herald)
Harvey Field runway gets a makeover, the first in 40 years

Aviation-related federal revenue is covering the cost. The Snohomish airport has been family-owned since 1944.

Heather Van Slageren waits for a Community Transit bus to Stanwood at the Lynnwood Transit Center on September 8, 2021. (Kevin Clark / The Herald)
As offices reopen, some former ‘super commuters’ aren’t happy

After a pandemic respite working at home, they dread resuming a one-way commute of 90 minutes or more.